Revenue Recognition Accounting for Software as a Service (SaaS)

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Sponsored by Tensoft, Inc. (www.tensoft.com)

Revenue Recognition Accounting for

Software as a Service (SaaS)

An Executive Webcast With

Jeffrey Werner

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Welcome to Today’s Event

• Viewing tips & CPE credit information

• About the webcast sponsor, Tensoft

• Introduction to today’s speaker

• Presentation: “Revenue Recognition

Accounting for Software as a Service

(SaaS)”

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Viewing Tips & CPE Credit

• For “Full Screen,” go to “View” on the Control

Panel

• Submit questions any time using the

“Question and Answer” pane

• CPE certificates will be emailed to everyone

who requested them during registration –

please allow 1 week

• Recording and slides will be available in the

Tensoft Resource Center in 24 hours

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End-to-End Business Software Solutions

For the Technology Industry

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Who is Tensoft?

Tensoft, Inc.

• Business software solutions provider

• Focus on technology companies

• Software for revenue management (RCM)

Tensoft RCM Product Line

• Complete revenue management suite

• Billing management for contracts

• Business model transaction flow support

• Visibility, Productivity, Compliance

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Tensoft RCM Revenue Management

Sales Transaction

• Generated based on Go-To-Market Model

• Generated from website, ERP, Tensoft RCM Contract

Revenue Basis

• Determination of policy for document type

• Revenue base determination

• Sales Transaction Based

• SOP 97.2 based – residual method

• EITF 08-01 based – relative value method

• Revenue rules, sub-ledger, and analysis

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Today

’

_’

s Presenter:

_{s Presenter:}

Jeffrey Werner,

Werner Consulting Group

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Sponsored by Tensoft, Inc. (www.tensoft.com) 9

SaaS Presentation Outline

• Introduction

• SaaS Business Model

• Four Revenue Recognition Principles

• SaaS Accounting

– When SaaS is Software

– When SaaS is Service

• Set Up Fees and Related Costs

• Consulting and Training Services

• Fees based on Usage

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Introduction to Werner

Consulting Group

Revenue Recognition Services Include:

• Pre-Contract Negotiations and Deal Structuring • Post-Contract Review, Analysis and Accounting • Best Practices Implementation

• VSOE Studies and Analysis • Customized Training Classes

• Revenue Recognition Technical Research and Whitepapers • Revenue Recognition Policy Implementation and Improvement • Peak Demand Contract Review

• Revenue Management Outsourcing • Audit Assistance

• Revenue Management Software Implementation • EITF 08-1 Implementations

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Upcoming Events

Software Revenue Recognition Webcast

Thursday May 19 Part One 9 am – 12:30 pm PDT

Wednesday May 25 Part Two 9 am – 12:30 pm PDT

CPE Credit

Pay per attendance

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Software Revenue Recognition Class

Software Revenue Recognition Agenda,

Day One:

– General Principles of Revenue Recognition – Multiple Element Arrangements

– VSOE

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Software Revenue Recognition Class

Software Revenue Recognition Agenda,

Day Two:

– Introduction and Agenda – Review - General Principles – Services Contract Accounting – Software as a Service (Saas) – EITF 08-1 and 09-3

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Questions / Slides

• Submit questions any time using the

“Question and Answer” pane

• Submit questions after the webcast to Jeffrey

Werner

wernerj@sbcglobal.net

• Questions and responses by email and on

Tensoft Blog

• Slides will be available to download after the

presentation

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SaaS

Business Model

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SaaS Business Model

History of Software Licensing

Time Share Model – the mainframe era Perpetual Licensing – mini and PC era

License Fees Support Fees

Implementation Fees

High cost of ownership – up front

Long Time to Implement – customization Term Licensing – EDA Industry Model

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SaaS Business Model

Software as a Service - SaaS

Evolution of the Internet Service vs ownership SalesForce.com

Industry Leader

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SaaS Business Model

Software as a Service – SaaS Customer Advantages

Easy to implement – ready to go, standard set-up Low upfront cost

Cost over time – pay as you go

Vendor keeps it running – lower internal IT costs Less administration of licenses – how many to buy Automatic updates

Easy access over the internet – browser interface Network based rather than PC based

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SaaS Business Model

Software as a Service – SaaS Vendor Advantages

Easier Sale – Lower Upfront Cost of Ownership Predictable Ratable Revenue

Easy To Upgrade and Change Features

Customers Locked in to Usage – hard to change to another Vendor

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SaaS Business Model

Software as a Service – SaaS Customer Disadvantages

Mission Critical Resource in Control of Vendor Data in Control of Vendor – Privacy Concerns Uptime dependent on Vendor and Internet

Vendor Disadvantages

No One Time Large Sales Revenue Must have customer service focus

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Revenue Recognition

General Principles

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General Principles of Revenue

Recognition

• Persuasive Evidence of an arrangement exists

• Delivery has occurred

• The fee is fixed and determinable

• Collectability is probable

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General Principles of Revenue

Recognition

Easy Memory Device - Not ABC – CDEF

• C – Collection

• D – Delivery

• E – Evidence

• F – Fixed

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Revenue Recognition Literature

– SOP 97-2 and 98-9

– SAB 101 and 104

– TPAs (AICPA Technical Practice Aids)

– EITFs – 00-3, 00-21, 03-5

– EITFs 08-1 and 09-3

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SaaS

Accounting

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SaaS Accounting

Is it Software or Service?

Software

Take possession – on customer server or right to take possession from vendor without significant costs

Customer has the ability to use independent of vendor Perpetual and Term right of use

Right and Ability to use without vendor License Fees and Support Fees

Upgrades – part of maintenance or upgrade fees Data at customer

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SaaS Accounting

Is it Software or Service?

Service

Hosted by Vendor

Monthly or Usage Fees Data on Vendor Server

Data Transition or Conversion Rights at End of Use Right to Use only

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SaaS Accounting

Software

Use SOP 97-2 Accounting

VSOE for Undelivered elements

Typically Recognize License on delivery Support Recognized over period

Service

Use EITF -8-1 Accounting

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Accounting for Elements of an

Arrangement

Two Step Process

1 – Separation

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Accounting for Elements of an

Arrangement

Separation of the Elements

– Individual elements are independent

• Functionally – one is not essential to the other

• Contractually – payments not linked or contingent • No related refunds or rights of return

– Individual elements have stand alone value • Sold separately by any vendor

• Have resell value

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Accounting for Elements of an

Arrangement

Allocation of Revenue to the Elements

– Software revenue recognition uses the

Residual Method

– Service revenue recognition uses ETIF 08-1

Relative Selling Method

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Accounting for Elements of an

Arrangement

Residual Method

– Defer the full value of undelivered elements

using Vendor Specific Objective Evidence

(VSOE)

– Allocate the remaining value or residual to

the delivered elements

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Accounting for Elements of an

Arrangement

Relative Selling Price Method

– Allocate to each element based each

element percentage of total (relative value)

– Value is based on VSOE, TPE or ESP

– Defer revenue for undelivered elements

– Recognize revenue for delivered elements

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Accounting for Elements of a SaaS

Arrangement

SaaS –Multiple Element Arrangements

Subscription Fees

Set-up Fees

Consulting

Training

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Accounting for Elements of a SaaS

Arrangement

SaaS – Multiple Element Arrangements

Is there Stand-Alone Value?

Often in SaaS the elements do not

have stand alone value

Stand-alone value includes items sold

separately by another vendor

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Up-Front Fees

SaaS – Up-Front Services (Set-Up Fees)

– Up-front services are a necessary and inseparable

part of obtaining the services

– Up-front services have little or no value without the ongoing services

– Customer cannot buy the up-front services from another vendor

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Up-Front Fees

Revenue from up-front services should be

accounted for either:

– over the initial contract period for

services

– over the expected customer

relationship period if greater than the

contract period if the customer will

benefit from the up-front services after

renewal

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Up-Front Fees and Costs

Costs that are incremental and directly

related to up-front services should be

accounted for either:

– Expensed as incurred, or

– Deferred and charged to expense

proportionally over the over the same

period as the related revenue

The accounting is an option of the vendor

and should be applied consistently

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Accounting for Elements of an

Arrangement

Multiple contracts or one arrangement?

TPA 39 Attributes than indicate contracts

are independent or related

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Issues to Consider – Multiple Contracts

• “TPA 39” Contracts - Multiple transactions with a Customer in a short time period

– Can be considered one contract for accounting

– An element without VSOE in one contract can effect other contracts with same customer

– All related contracts must be complete and signed for any revenue to be recognized

– Services SOW referenced or negotiated or being negotiated

within the similar timeframe as the license could be considered a related contract

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Issues to Consider – Multiple Contracts

• Indicators That Contracts Are Related:

– The contracts or agreements are negotiated or executed within a

short timeframe of each other.

– Contracts are executed by the same person.

– The different elements are closely interrelated or interdependent

in terms of design, technology, or function.

– The fee for one or more contracts or agreements is subject to

refund or forfeiture or other concession if another contract is not completed satisfactorily.

– One or more elements in one contract or agreement are

essential to the functionality of an element in another contract.

– Payment terms under one contract or agreement coincide with

performance criteria of another contract or agreement.

– The negotiations are conducted jointly with two or more parts of

the customer’s organization (for example, from different divisions of the same company) to do what in essence is a single project.

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Accounting for Elements of an

Arrangement

Usage Fees Revenue Recognized When

Usage occurs

Service Meter approach – like the electric

bill

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Accounting for Elements of an

Arrangement

Example # 1 – Old Accounting under 00-21

Vendor sells online service $12,000 one year contract

$1,000 monthly service fee - one year contract Renewable in year two for $1,000

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Accounting for Elements of an

Arrangement

Example # 1 – EITF 00-21 Accounting

Residual Method based on VSOE

NO LONGER USED

$1,000 monthly service fee - VSOE $5,000 set-up fees – delivered

Defer monthly fee at VSOE

Recognize service fee $1,000 monthly

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Accounting for Elements of an

Arrangement

Example # 2 – EITF 08-1 Accounting

Relative Selling Price Method

$12,000 ($1,000 monthly service fee – VSOE) $ 5,000 set-up fees – delivered

$17,000 Total Transaction fee Allocate using relative selling price

VSOE for monthly service BESP for set-up fees

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Accounting for Elements of an

Arrangement

Example # 2 –

Relative Selling Price Method

$12,000 service fees – VSOE – 60% $ 8,000 set-up fees – BESP – 40% $20,000

$10,200 service fees at 60% - $850 month

$ 6,800 set-up fees at 40% - $189 month ($6,800 / 36) $17,000 total arrangement fee

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Accounting for Elements of an

Arrangement

Comparison

Example # 1 Residual Method - No Longer Used Year one

$12,000 Monthly Fee

$ 1,667 1/3 set up fee ($5,000 / 3) $13,667

Example # 2 Relative Selling Price Method Year one

$10,200 Monthly Fee

$ 2,267 1/3 set up fee ($6,800 / 3) $12,467

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Accounting for Elements of an

Arrangement

Example # 3

Vendor sells online service

$12,000 $1,000 monthly service fee - one year contract Renewable in year two for $12,000

$10,000 Training - $2,000 day VSOE $22,000 Total Transaction Fee

Does the Training have a separate value from the monthly service?

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Accounting for Elements of an

Arrangement

Example # 3 – EITF 00-21 & 08-1 Accounting

$ 1,000 monthly service fee - VSOE

$10,000 Consulting / Training

Defer monthly fee at VSOE

Recognize service fee $1,000 monthly

Recognize Training when completed (assuming

Training has separate stand-alone value)

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Accounting for Elements of an

Arrangement

Example # 4 –

Customization Services

$100,000 Annual Subscription Fee

renewable for year 2 $100,000 (VSOE)

$ 50,000 Customization Services

Do the customization services have stand-alone

value?

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Accounting for Elements of an

Arrangement

SaaS – Example # 4

–

Customization Services

The customization services have no stand-alone value because the customer only obtains value from the services through the use of the subscription services Therefore the hosted services and the customization

services should be treated as a single unit of accounting Recognize revenue $150,000 revenue ratably over one

year subscription period ($12,500 month)

Capitalize and expense customization costs or expense as incurred depending on company policy election

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Conclusion

Revenue Recognition Resources

• Big Four Revenue Recognition Guides

• Big Four Revenue Recognition Whitepapers • AICPA

• FASB / EITF • SEC Filings • Webcasts

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Q & A

To submit a question now, please click on

“Question and Answer.”

Then just type your question in the space

under “Enter a Question”

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Additional questions or comments?

Please contact:

Jeffrey Werner

Email

wernerj@sbcglobal.net

Werner Consulting Group

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Upcoming Events

Software Revenue Recognition Webcast

Thursday May 19 Part One 9 am – 12:30 pm PDT

Wednesday May 25 Part Two 9 am – 12:30 pm PDT

CPE Credit

Pay per attendance

(56)

Software Revenue Recognition Class

Software Revenue Recognition Agenda,

Day One:

– General Principles of Revenue Recognition – Multiple Element Arrangements

– VSOE

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Software Revenue Recognition Class

Software Revenue Recognition Agenda,

Day Two:

– Introduction and Agenda – Review - General Principles – Services Contract Accounting – Software as a Service (Saas) – EITF 08-1 and 09-3

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Conclusion

Werner Consulting Group

Revenue Recognition Services Include:

• Pre-Contract Negotiations and Deal Structuring • Post-Contract Review, Analysis and Accounting • Best Practices Implementation

• VSOE Studies and Analysis • Customized Training Classes

• Revenue Recognition Technical Research and Whitepapers • Revenue Recognition Policy Implementation and Improvement • Peak Demand Contract Review